Outlook for Agriculture: Does a Downturn Loom

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Outlook for Agriculture Does a Downturn Loom?

• Bruce A. Babcock
• Center for Agricultural and Rural Development
• Iowa State University
• Presented at the Pro-Ag Meeting in Fort Dodge,
  Iowa November 12, 2008

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World Demand

• Likely a severe downturn in income growth
• U.S., EU, China, India, Japan, S. Asia
• Drop in income growth will hold down growth in
  demand for meat, wheat and feed grains
• Food demand is income inelastic, but demand for
  meat and dairy products income elastic in many
  areas of the world

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30 of U.S. Corn Crop
14 of U.S. Corn Crop
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Size of the US Crop
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Wheat Production Increases

• Ukraine up by more than 50
• Australia up by more than 70
• EU up by 23
• Canada up by 20
• US up by 12

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Commodity Economics

• High prices encourage investment in production
  capacity
• Increased capacity is semi-irreversible
• No real limits on production capacity if
  investment occurs

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Why is the Dollar Stronger?

• Relative safety against turbulent times
• Reduction in demand for commodities

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Impact of a Stronger Dollar

• Lower crude oil prices
• Lower ethanol prices
• Reduced demand for corn from ethanol
• Reduced export demand for U.S. agricultural
  commodities

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Supply and Demand Outlook

• Commodity bust bad news for U.S. agriculture
• Lower overall food demand growth will lead to
  lower agricultural prices
• Bright side of the bust
• Credit constraints and lower prices will reduce
  capacity-increasing investment
• Lower input costs will partly cushion blow
• Ethanol RFS

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Impact of the RFS

• Renewable Fuels Standard requires 9 billion
  gallons of biofuels in 2008, 10.5 billion gallons
  in 2009
• Gasoline producers must either blend their share
  of ethanol or buy a RIN (Renewable Identification
  Number) from another producer
• If ethanol becomes scarce, RIN price will
  increase, thereby increasing the price of ethanol
• Ethanol producers have to be induced through a
  high price to produce required ethanol
• Increases in ethanol price will keep corn prices
  high

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Break-Even Corn Price

• Ability to pay for one bushel of corn
• Price of ethanol 2.8 gals/bu minus
• per bushel processing and capital costs plus
• per bushel value of byproducts

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Ethanol Plants are Setting the Price of Corn

• Changes in the ability to pay for corn very
  closely related to the actual price of corn
• Relationship should continue to hold so long as
  there are idle ethanol plants

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Why Hasnt Ethanol Followed Gasoline Lower?

• RFS is binding
• Resolution of transportation bottlenecks
• Should be willing to pay 0.51 above the price of
  gasoline for ethanol if one for one substitute
• Right now, ethanol is 0.40 above gasoline

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Longer-Run Outlook

• Corn will follow crude higher, but not lower if
  ethanol plants do not produce enough ethanol
• For 2009, we need about 87 million acres of corn
  to produce the mandate
• Corn prices relative to soybean prices will need
  to be high enough to buy the acres
• If not, then corn prices will increase
  significantly next year

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Outlook continued

• Credit constraints should work to hold world
  supplies down
• Need to produce corn should help keep corn
  margins at a decent level
• Key importance is to keep the RFS and import
  tariff in place if corn margins are to be
  maintained for a year of two